Customer Demand: Foundations

Question 1

Willingness to Pay (WTP)

Answer 1

Willingness to pay is the maximum amount of money a customer is willing to pay for a product or service.

Question 2

A demand curve for an individual buyer simply summarizes

Answer 2

A demand curve for an individual buyer simply summarizes that consumer’s willingness to pay for various quantities of a product.

Question 3

demand curves Y axis = ; X axis = ;

Answer 3

price on the y-axis, and quantity demanded on the x-axis.

Question 4

An individual’s demand curve is typically _____ sloping because _____

Answer 4

downward sloping because a consumer will have a higher WTP for the first unit of a product, but a lower WTP for subsequent units. This is due to “diminishing marginal returns.”

Question 5

Market demand curves are ______ sloping because ______

Answer 5

Market demand curves are downward sloping because fewer consumers are willing to purchase the product at higher prices.

Question 6

Changes in consumer willingness to pay result in shifts of the demand curve. For example, an increase in a consumer’s WTP for a product will shift her demand curve ___

Answer 6

outward

Question 7

a decrease in WTP will shift her demand curve ____

Answer 7

inward

Question 8

Slopes versus shifts:

Answer 8

Changes in price correspond to movements along the demand curve. Non-price factors that affect WTP correspond to shifts in the demand curve (inward or outward).

Question 9

The slope of a market demand curve measures

Answer 9

how responsive buyers are to changes in price.

Question 10

When the curve is flat or near-flat…

Answer 10

a small dip in price sparks a large surge in the quantity demanded.

Question 11

When the curve is steep or vertical

Answer 11

changes in price have little impact on the quantity demanded.

Question 12

Steep curves are often called

Answer 12

“inelastic,”

Question 13

flat curves are often called

Answer 13

“elastic.”

Question 14

Demand is typically more elastic if

Answer 14

a product is a luxury rather than a necessity, or if the product has many substitutes.

Question 15

The “price elasticity” of demand is calculated as

Answer 15

as the percentage change in quantity demanded divided by the percentage change in price.

Question 16

Example of a product with negative income elasticity of demand:

Answer 16

Rice
A negative income elasticity of demand implies that a consumer will buy less of a good as his or her income increases. This could be the case for cheaper foods such as rice. A consumer with a higher income might be able to afford more expensive foods and switch to, say, quinoa, fish or steak instead.

Question 17

Suppose that your WTP for one stick of deodorant is normally $5. The price of deodorant is also typically $5. However, this week your local store is having a buy one, get one (“BOGO”) free sale on your favorite brand. What is your WTP for one stick of deodorant now?

Answer 17

$5
Even with the buy one, get one (“BOGO”) free sale, your WTP remains at $5. This is because price does not affect your WTP.

Question 18

“extrinsic” or “observable” differences =

Answer 18

These are things that you can generally determine about people without actually asking them, such as where they live, whether they are young or old, and so on.

e.g. age, gender, income, or education

Question 19

“intrinsic” =

Answer 19

things that you couldn’t know about a person without asking him or her. They’re hard to observe (and for that reason are also referred to as “unobserved differences”). For example, a person’s tolerance for risk, his or her wish to fit in with others or stand out from others, or even the intensity of his or her passion for Taylor Swift or the New England Patriots.

Question 20

Diminishing Marginal Returns - concept that

Answer 20

concept that means that the more you sell, the harder and harder it is to sell more. Also implies that there are how large the business can be.

Question 21

3 factors that determine whether the demand curve for a product is steep or flat?

Answer 21

SUBSTITUTE OR NOT: For one, it depends on whether the product has close substitutes or not. Chocolate ice cream has a lot of close substitutes (cookie dough ice cream, chocolate cake, other desserts). If the price of chocolate ice cream suddenly rises, consumers will simply switch to the other products. Baby formula on the other hand has few close substitutes.

NECESSITY OR LUXURY: Secondly, it depends on whether the product is a necessity or a luxury. Chocolate ice cream is a luxury good. (That is, despite what some of us may think, we can live without it.) On the other hand, baby formula is considered a necessity. Even if its price rises, consumers will continue purchasing it.

TIME HORIZON: Consider the demand for gasoline. In the short run, the demand curve for gasoline is quite steep—there are few substitutes and, for many people, driving is a necessity. But over time, people can move closer to work, we can discover alternate fuels, etc. This can cause the demand curve for gasoline to flatten out in the longer run.

Question 22

Example of a very steep, almost vertical curve:

Answer 22

a demand curve can be so steep that it is perfectly vertical. Here customers will buy a given quantity no matter what the price. One example that comes close to this case is the demand for insulin by diabetics.

Question 23

Example of a very flat curve:

Answer 23

a demand curve can be so flat that even a small increase in price would drive all customers away. A classic example is demand for paper currency. If someone tried to sell us a $20 bill for anything more than $20 worth of value, we would take our business elsewhere.

Question 24

4 Things to Keep in mind about DEMAND CURVES:

Answer 24

1 - They just summarise the willingness to pay by consumers
2 - Can be flat or steep (why would more people pay more for 1 game, and less for another?) Elastic (Flat) - Inelastic (Steep)
3 - They can move around over time, as WTP changes over time; Demand Shifters
4 - We can look at demand curves for single individuals - how does WTP changes with quantity increases

Question 25

The Definition of Elasticity

Answer 25

is the percentage change in quantity demanded divided by the percentage change in price.

Elasticity is the percent change in quantity demanded divided by the percent change in price.

Question 26

“value-based pricing” =

Answer 26

setting prices based on WTP rather than (just) costs

Question 27

The income elasticity of demand:

Answer 27

How sensitive is demand to changes in consumer incomes? Some products might not be much affected by changes in your income. For example, if you’re not diabetic, you’re probably not going to start buying insulin just because you’ve become wealthier. Other products, such as jewelry, might be very sensitive to changes in income. There are even some goods you might buy less of as your income increases. You might stop buying packets of ramen noodles and start eating more expensive food.

Question 28

Cross-price elasticity of demand:

Answer 28

How sensitive is demand for your product to changes in prices of other products? This is particularly useful to understand the effects of competitive responses and actions—and which other products really affect your demand.